News Analysis: Mexico Considering Tougher Tax Treatment of Some Maquiladora Operations
by John A. McLees and Hector Reyes-Freaner
Mexico is considering amendments to its maquiladora decree to impose new conditions on the ability of a substantial number of maquiladoras and their foreign affiliates to benefit from protections from income tax and single-rate tax exposure that are now available to all maquiladora operations that operate under a consignment manufacturing arrangement between the maquiladora and the foreign company.
The changes that are reported to be under consideration would eliminate the ability that these maquiladoras have always had to implement consignment manufacturing without unacceptable tax exposures in Mexico, and would impose those exposures on maquiladoras and their foreign affiliates in that group that have already implemented consignment manufacturing.
An equally important concern for all maquiladoras is the possibility that these changes for some maquiladoras and their U.S. affiliates could call into question Mexico's compliance with its agreement with the United States to grant a PE exemption to all U.S. companies that enter into a consignment manufacturing arrangement with a maquiladora and satisfy agreed standards for compensating the maquiladora for its processing services.
Exports account for a large portion of the manufacturing sector in Mexico, and the vast majority of export manufacturing is conducted by Mexican companies known as maquiladoras or maquilas, which operate under temporary importation programs, known as maquiladora programs, issued under Mexico's maquiladora decree (now also known as the Decree for the Development of the Manufacturing, Maquiladora and Export Services Industry, or IMMEX Decree).
Mexico recognizes that export manufacturing is highly mobile and has sought to encourage multinational companies to locate their export manufacturing operations in Mexico. Tax relief granted to maquiladora operations has always been an important means by which the Mexican government has attempted to attract and keep export manufacturing. A maquiladora program is essentially a tax program that allows a maquiladora to import goods and equipment temporarily without paying VAT and, in the case of goods, without paying custom duties.
Typically, but not always, maquiladoras undertake their manufacturing activity through consignment manufacturing arrangements, under which a foreign company (usually a U.S. company) pays an affiliated or unaffiliated maquiladora to manufacture products owned by the foreign company, using equipment owned by the foreign company that is made available for use by the maquiladora without charge.
Mexico has granted special tax relief to maquiladoras that operate in that way, as well as protection from Mexican tax exposures to the foreign parties that participate in consignment manufacturing operations with a maquiladora.
Apart from the relief from VAT and customs duties on temporary importation under a maquiladora program and the relief from VAT on maquiladoras' invoices to foreign parties for the processing services, special tax rules and protections for maquiladoras and their foreign affiliates are set forth in:
- the Mutual Agreement on Maquiladora Taxation entered into between the United States and Mexico in 1999;
- the provisions of the income tax law that implement Mexico's commitments under the mutual agreement and apply them to U.S. companies and other foreign companies; and
- the presidential decrees that Mexico issued in October 2003 regarding the Mexican income tax treatment of maquiladoras, and in November 2007 to moderate the burden of Mexico's new single-rate tax on export manufacturing operations conducted by maquiladoras.
By their terms, these tax laws and the mutual agreement grant those protections and benefits to all maquiladoras (that is, to all companies that conduct their manufacturing operations under maquiladora programs granted under Mexico's maquiladora decree) and to the foreign companies that enter into consignment manufacturing arrangements with maquiladoras.
Changes Being Considered for Some Maquiladora Operations
Mexico is considering the elimination of these tax protections for a substantial number of maquiladora operations that do not, and in many cases could not, meet certain new conditions regarding the origin of their inputs or the ownership and past ownership of the equipment they use in their operations.
Specifically, according to reports that have surfaced recently, Mexico is seriously considering amendments to its maquiladora decree that could prevent maquiladoras that do not meet the new requirements from enjoying the income tax and single-rate tax benefits that apply to maquiladoras under Mexican law and that could prevent U.S. companies and other foreign companies that engage in consignment manufacturing arrangements with those maquiladoras from benefiting from the existing exemption from Mexican income tax or single-rate tax liability that would result from having a permanent establishment in Mexico.
The new conditions reportedly would include restrictions on prior ownership by the maquiladora of the equipment that the foreign company is making available to the maquiladora for use in its operations. The purpose of those restrictions would be to address Mexican tax authorities' concerns about Mexico's actions in November 2006 in (1) repealing Mexico's other temporary importation regime for export manufacturing operations (the so-called PITEX decree) and (2) causing all of the companies previously operating under PITEX programs granted under that degree instead to be granted temporary importation programs under the maquiladora decree, thereby converting those companies into maquiladoras (also known as IMMEX companies).
The objective of the proposed new requirements would be to limit the ability of maquiladoras that previously operated as PITEX companies from entering into consignment manufacturing arrangements and to force at least some of them to continue to engage in buy-sell operations, with the Mexican company owning the equipment used in its operations. Depending on the details of any new requirements, that could have the effect of penalizing former PITEX companies and their U.S. affiliates that adopted consignment manufacturing in reliance on Mexico's invitation to do so when it amended the maquiladora decree in 2006, if those companies could not meet the new requirements.
According to some reports, the new conditions would also apply to new maquiladoras -- those with maquiladora programs approved since the maquiladora decree was amended in November 2006 that have structured their operations to utilize consignment manufacturing in reliance on the current rules.
Mexico would attempt to implement these changes by characterizing those Mexican companies, all of which now operate under a maquiladora program, and all of which now constitute maquiladoras for all purposes, as not constituting maquiladoras solely for certain tax purposes unless they meet new requirements regarding the current and prior ownership of the equipment they use in their operations. This would deprive the U.S. companies that deal with maquiladoras that don't meet the new conditions of the protection from having a PE in Mexico, which Mexico has agreed with the United States to provide to all such U.S. companies that meet the standards set forth in the mutual agreement for the amounts they pay to maquiladoras for their processing services.
Other proposed amendments to the maquiladora decree would attempt to recharacterize other companies that now operate under a maquiladora program and that therefore constitute maquiladoras for all purposes, as not constituting maquiladoras solely for tax purposes if a majority of the inputs owned by the foreign party was locally sourced in Mexico. These proposed changes would be intended to prevent the tax benefits described above from applying to maquiladora operations that are engaged in agricultural production in Mexico.
The reports that have surfaced recently also suggest that the new rules could exclude certain services maquiladoras from the maquiladora tax regime, potentially including those dedicated to supply and distribution, storage and warehousing, design centers, call centers, and so on.
Mexican Concerns Regarding the Proposed Changes
There are several reasons, from a Mexican perspective, to question the wisdom of the proposed amendments to the maquiladora decree.
It appears likely that the changes would severely penalize some maquiladoras that have relied on current Mexican law in converting their export manufacturing operations into consignment manufacturing. If the proposed changes are adopted, those companies would be forced to restructure their operations again to eliminate or curtail their use of consignment manufacturing in order to avoid PE exposure for the U.S. company and the imposition of single-rate tax on the maquiladora in an amount that could exceed 50 percent of its taxable income for income tax purposes.
Treating existing manufacturing operations fairly, and maintaining a reputation of treating them fairly, is of primary importance in preserving Mexico's ability to attract and keep export manufacturing operations. Whether or not the restrictions would be subject to a challenge as a retroactive imposition of changes in the tax law, most companies would consider it unfair to change the implications now for transactions that companies have engaged in during the past several years, regardless of whether the changes affect them directly.
The proposed changes would also deprive all maquiladoras that were formerly PITEX companies of the alternative that they have always enjoyed, before and since the repeal of the PITEX decree in 2006, to utilize consignment manufacturing arrangements under a maquiladora program. Prior to the repeal of the PITEX decree, many PITEX companies did exactly that by individually obtaining a maquiladora program and cancelling their PITEX programs. The ability to do that routinely, and thereby to make use of consignment manufacturing operations under the protection of a maquiladora program, has enabled Mexico to retain export manufacturing operations in sectors such as the automotive sector in companies that were originally structured as PITEX companies after it no longer made sense from a financial perspective to be structured that way.
It is in Mexico's interest to provide such companies, which may have utilized the PITEX program without full consideration of its limitations, the flexibility to implement changes that will optimize global costs through the use of consignment manufacturing. This is what Mexico has done, and this is the policy that it now proposes to abandon.
Restrictions on the use of domestic inputs could also disrupt the existing programs of manufacturing maquiladoras to diversify the sources of their inputs to include more Mexican-source inputs. Indeed, restricting the use of Mexican inputs by maquiladoras engaged in export manufacturing would be contrary to Mexico's long-standing policy of promoting the use of materials and components acquired from Mexican suppliers in export manufacturing in order to promote the growth of the manufacturing sector. Companies are gradually beginning to respond by searching for Mexican suppliers that can fulfill their needs, and Mexico should be careful not to discourage those efforts.
Similarly, the exclusion of services operations from the maquiladora tax regime could undermine Mexico's drive to attract services such as engineering and design because it could subject such operations to a level of single-rate tax that is equal to a large percentage of the taxable income they recognize for income tax purposes.
Potential U.S. Tax Implications for Maquiladora Operations
The proposed changes should be of concern to all maquiladoras and their foreign affiliates, not just to those being targeted by the proposed changes, because of the questions that those changes could raise about the continuing application of the mutual agreement and, in particular, the continuing application of the agreement of the United States to allow U.S companies to deduct the entire amount of the payments they make to maquiladoras for their processing services. This is because the changes could call into question Mexico's compliance with its commitment to the United States under the mutual agreement to grant a PE exemption to U.S. companies that enter into consignment manufacturing arrangements with maquiladoras generally, without exceptions such as those that Mexico is now considering.
Mexico's agreement to grant that PE exemption to U.S. companies is the quid pro quo for the agreement of the United States, under the terms of the mutual agreement, to grant a tax deduction for the full amount of the payments that Mexico now requires foreign companies to make to maquiladoras, which the United States would not do in the absence of the mutual agreement. Thus, any failure by Mexico to comply with the obligations it has undertaken under the terms of the mutual agreement would raise the question of how the United States would respond in the future in implementing its agreement to allow a full deduction for the amounts that a U.S. company pays to a maquiladora for its processing services.
The new rules that Mexico appears to be considering would not change the requirements for obtaining a maquiladora program or operating under a maquiladora program (that is, the requirements for being a maquiladora). Nor would the new rules place new conditions on the circumstances in which companies can operate as maquiladoras and obtain the VAT and customs benefits for temporary imports of goods and equipment. Thus, the proposed changes would not in any way alter Mexico's obligation under the mutual agreement to provide a PE exemption equally to U.S. companies that enter into consignment manufacturing operations with maquiladoras that were once PITEX companies, or whose maquiladora program was approved after October 2006, or that make use of domestic inputs. Therefore, if Mexico were to adopt these changes, it would be breaching its obligation under the mutual agreement to provide the PE exemption to U.S. parties dealing with those maquiladoras.
This result is not changed by Mexico's attempt to implement its restrictions by redefining some maquiladoras as not being maquiladoras solely for tax purposes. It has been said that a rose is a rose is a rose. Similarly, nothing in the mutual agreement or in the provisions of the Mexican income tax law that implement the mutual agreement in any way contemplates that Mexico could arbitrarily redefine some maquiladoras as not being maquiladoras solely for certain tax purposes (that is, solely for the purpose of depriving them of the tax benefits granted to all maquiladoras under Mexican law and depriving the foreign companies dealing with those maquiladoras of the PE exemption that Mexico has agreed to provide under the mutual agreement). Thus, attempting to make such a distinction between one maquiladora and another for the sole purpose of depriving a substantial portion of maquiladora operations of the treatment now accorded to all maquiladora operations would call into question Mexico's compliance with the mutual agreement, specifically with the conditions that Mexico agreed to meet in exchange for the agreement of the United States to allow a shift of taxable income from U.S. companies to their affiliated maquiladoras so as to be taxed in Mexico instead of in the United States.
This is a serious concern for all maquiladoras, regardless of the nature of the additional requirements that Mexico would impose on some, but not all, maquiladora operations as a condition for obtaining the PE exemption. It would be a more serious concern if the specific requirements were defined in such a way that it would be difficult as a practical matter for maquiladoras that were once PITEX companies to meet the new requirements or if the rules are drafted in a way that would directly affect the operations of maquiladoras that are not among those that Mexico is seeking to target with the new restrictions.
Current Status of the Proposals
According to a bulletin released by the National Council of Maquiladora Associations, the Mexican tax authorities have submitted or will soon submit a final text of the proposed changes to the Federal Regulatory Improvement Commission for consideration. Interested parties will want to obtain the text of those changes and to register their comments and concerns with the commission.
Background
Development of the Maquiladora Tax Regime
Allowing maquiladoras to import goods and equipment without the payment of VAT -- and in the case of goods, without the imposition of custom duties -- and exempting payments to maquiladoras for their processing services from VAT continue to be the primary functions of the maquiladora decree and related provisions of the VAT law applicable to maquiladora operations. Export manufacturing operations still rely primarily on imported raw materials, components, and equipment, and this temporary importation regime allows that to happen without excessive tax burdens that could cause companies to locate their export manufacturing operations elsewhere.
The second important tax issue for export manufacturing in Mexico is the need to protect the foreign companies themselves from Mexican tax exposure. Most maquiladora operations have been conducted as consignment manufacturing, with a foreign company paying an affiliated or unaffiliated maquiladora to manufacture products owned by the foreign company using equipment owned by the foreign company and made available to the maquiladora on free bailment. It would be unacceptable to U.S. companies and most other foreign companies to be subject to Mexican tax on a portion of the income they earn from selling products that an affiliated or unaffiliated party has manufactured in Mexico, on the grounds that the foreign company has a PE in Mexico.
Therefore, in 1999 the United States and Mexico took the extraordinary step of entering into the Mutual Agreement on Maquiladora Taxation, under which Mexico agreed not to impose income tax on a U.S. company that enters into a consignment manufacturing agreement with a maquiladora if the U.S. company pays a higher than normal price to the maquiladora for its processing services, under standards set forth in the agreement. In exchange for that commitment from Mexico, the United States agreed to allow U.S. companies to deduct the full amount of those higher payments for U.S. income tax purposes. (For prior coverage, see Doc 1999-35170 or 1999 WTD 211-1 .)
In 2002 Mexico enacted those standards into law as the conditions under which Mexico will grant a foreign company that enters into a consignment manufacturing arrangement with a Mexican maquiladora company an exemption from being subject to income tax in Mexico on the grounds that it has a PE in Mexico. These rules apply to all consignment manufacturing operations involving maquiladoras, but only those involving maquiladoras. (For prior coverage, see Doc 2003-2326 [PDF] or 2003 WTD 17-13 .)
Mexico has also recognized that it is in a global competition with other countries that provide favorable tax treatment to local companies engaged in export manufacturing. Therefore, in October 2003, under a presidential decree that remains in effect, Mexico reduced the income tax rate applicable to maquiladoras on income they earn from their manufacturing activities if they engage in consignment manufacturing. This special income tax rate applies to all maquiladoras, and only to maquiladoras.
Mexico's imposition of its new single-rate tax, which went into effect at the beginning of 2008, created another major tax issue that could have impaired Mexico's competitiveness in attracting and retaining export manufacturing operations by imposing tax equal to 50 percent more of the income tax base of a manufacturing company operating under a consignment manufacturing arrangement if it was required to use the normal tax base defined under the single-rate tax law. (For prior coverage, see Doc 2007-21322 [PDF] or 2007 WTD 190-7 .)
Mexico resolved that problem for maquiladoras in a presidential decree issued in November 2007. Under that decree, only maquiladoras may apply the single-rate tax at a combined rate of 17.5 percent (17 percent in 2009) to a specially defined amount that is close to their income tax base. (For prior coverage, see Doc 2007-25250 [PDF] or 2007 WTD 224-2 .) These special rules for maquiladoras maintain the total income tax and single-rate tax burden for maquiladoras at a rate significantly below the normal income tax rate of 28 percent (which will go up to 30 percent for 2010 through 2012 under legislation recently approved by the National Congress), while significantly increasing Mexico's tax collections from maquiladoras from what they were before the enactment of the single-rate tax.
Mexico's Tax Collections From Maquiladora Operations
The special tax regime that Mexico has implemented for maquiladora operations increases Mexico's tax revenues in several ways.
First, by reducing uncertainty and eliminating unacceptable tax exposures for the foreign companies, the special rules enable Mexico to collect income tax and single-rate tax from companies that would not otherwise have located or expanded their operations in Mexico, as well as payroll taxes that it would not otherwise collect from the Mexican individuals whom those companies employ. The protection that the current tax regime provides for a foreign company to engage in consignment manufacturing with its maquiladora is particularly important for companies in the automotive sector and for other companies with losses. Those companies would have an incentive to curtail their operations in Mexico and either keep more of them at home or put them in countries with more favorable income tax regimes if the only acceptable way to operate in Mexico was to allow a Mexican affiliate to operate as a buy-sell company and pay additional Mexican income tax that, for such a U.S. company, would be an extra cost.
Second, the direct effect of the mutual agreement and the rules implementing it is to increase the income tax paid by Mexican maquiladoras by increasing payments to them for their processing services from what the United States would otherwise allow a U.S. company to pay under a consignment manufacturing arrangement without losing a part of its deductions for those payments. That, of course, benefits Mexico.
Third, during periods such as the current period in which firms are losing money on their global operations, meeting either of the alternatives set forth in the mutual agreement and Mexican law for determining payments to a maquiladora for its manufacturing services causes the maquiladora to continue to have taxable income even when the global group is losing money. Otherwise, such companies could in many cases justify transfer pricing policies that would shift losses to the Mexican company, thereby reducing Mexico's tax revenues in the current year and future years.
Fourth, the Mexican tax authorities have most likely not taken into account the significant additional income tax revenues that Mexico receives from maquiladoras operated by profitable U.S. companies with capital-intensive operations as a result of the unique tax regime provided under the mutual agreement. In that agreement, the United States and Mexico agreed to allow companies to choose each year between satisfying special transfer pricing rules or meeting the safe harbor alternative of paying the maquiladora enough that its taxable income will be no less than 6.9 percent of the value of all assets used in its operations. Because of the favorable tax rates and single-rate tax protection that maquiladoras enjoy, profitable U.S. companies with capital-intensive operations in Mexico often choose the safe harbor alternative. That can greatly increase the taxable income of the maquiladoras and the total Mexican tax collections from such operations from what they would be without the special maquiladora tax regime. That has also been a factor in the decision of several profitable U.S. companies to locate or expand their maquiladora operations in Mexico.
Taking these factors into account might cause the Mexican tax authorities to moderate their views about the net impact of the maquiladora tax regime on tax collections in Mexico.
Mexico should also consider the extent to which an effort to curtail the transformation of maquiladoras that were once PITEX companies to consignment manufacturing under their maquiladora programs would itself have a detrimental impact on Mexico's total tax collections. That will be the result if limiting their historical freedom to restructure their operations in that way causes some companies to curtail the operations that they would otherwise locate in Mexico, by for the first time forcing them either to stay in a cost structure that is untenable for them in the current business environment or to establish an entirely new maquiladora operation. The loss of an export manufacturing operation results in the loss of payroll tax revenue as well as the loss of revenue from income tax, single-rate tax and VAT.
In any event, Mexico does not want to jeopardize the flow of new companies setting up maquiladora operations in Mexico by pulling the rug out from under companies that have relied on the current tax rules, nor does it want to jeopardize the U.S. tax benefits flowing to U.S. companies from the mutual agreement by raising questions about whether Mexico is complying with the obligations that it undertook under the terms of the mutual agreement.
Maquiladoras That Were Once PITEX Companies
It was largely a historical accident that Mexico had maintained two separate temporary importation programs under two separate decrees, and by 2006 the trade rules for PITEX programs and maquiladora programs had evolved to the point that they were virtually identical. What was clear, however, was that only companies with maquiladora programs granted under the maquiladora decree benefited from the tax rules discussed above. The mutual agreement and Mexican law expressly tie the tax rules discussed above to companies that operate under temporary importation programs issued under the maquiladora decree. PITEX companies did not benefit from those rules. The only tax benefits they received were from the temporary importation program itself (namely relief from VAT on temporary imports of goods and equipment and from customs duties on the temporary importation of goods for use in the manufacturing operations).
Companies operating under a PITEX program uniformly did not operate as consignment manufacturers, though there was no restriction on their operating in that way. The reason they did not was because, in the absence of the statutory PE exemption for the foreign company operating in that way with a PITEX company, the foreign company itself would have been exposed to an unacceptable risk of being subject to Mexican tax on the grounds that it had a PE in Mexico.
It was never difficult, however, for a PITEX company that wanted to operate as a consignment manufacturer under a maquiladora program to do so by simply obtaining approval of a maquiladora program, which it could obtain quickly and routinely, and canceling its PITEX program. Many companies took this administrative step and thereby became legally entitled to the PE exemption and other tax rules applicable to maquiladora operations that allowed them to implement consignment manufacturing.
By repealing the PITEX decree and granting maquiladora programs en masse to all companies that had previously operated under PITEX programs, rather than requiring them to obtain maquiladora programs routinely one by one, Mexico caused all those companies to be maquiladoras for all purposes, including for purposes of the mutual agreement, the Mexican income tax law, and the decree governing the income tax rates applicable to maquiladoras. (For prior coverage, see Doc 2006-16477 [PDF] or 2006 WTD 172-9 .) Later, all maquiladoras, including former PITEX companies and maquiladoras whose programs were approved after November 1, 2006, benefited from the decree issued in November 2007 allowing all maquiladoras, and only maquiladoras, to use their income tax base in computing their single-rate tax liability.
Since November 2006, this situation has been uniformly recognized by Mexico's tax authorities and by the United States, and companies have relied on it in structuring their operations and filing their tax returns in Mexico and the United States. Since then former PITEX companies and other maquiladora companies, old and new, have relied on their legal right to engage in consignment manufacturing operations and related transactions and to benefit from the Mexican tax rules applicable to such operations.
Of course, Mexico was not required to convert all PITEX companies into maquiladoras, thereby subjecting them to the tax and trade rules applicable to maquiladoras, as it did in 2006. Nor is there anything stopping Mexico from prospectively placing uniform conditions on which companies can obtain new temporary importation programs as maquiladoras in the future, or other uniform conditions that all maquiladoras must satisfy, whether or not it would be wise to do so. That should not violate Mexico's obligations under the mutual agreement with the United States. That does not, however, mean that once Mexico has decided to grant a maquiladora program to a company and to treat it as a maquiladora, it can by sleight of hand claim that it is not a maquiladora solely for purposes of denying it and its foreign affiliate the benefits of tax rules that are applicable under the law to all maquiladoras and to the foreign companies that contract with them for manufacturing services under a consignment manufacturing arrangement.
It is important to recall that versions of this same idea of manipulating the definition of maquiladora only for some maquiladoras solely for tax purposes were considered and rejected back in November 2006, when the maquiladora decree was amended and renamed the maquiladora decree in connection with the repeal of the PITEX decree and the transformation of all former PITEX programs into maquiladora programs. The explicit consideration and rejection of those alternatives at that time reinforced the understanding of maquiladoras and their foreign affiliates that they could rely on the tax rules applicable to maquiladoras under Mexican law and the mutual agreement. It is this reliance that Mexico would now undermine by changing the rules for companies that have implemented consignment manufacturing in the meantime and that do not meet new requirements that Mexico would impose on the origin of their inputs or the ownership of the equipment used in their operations.
What Can Mexico Do?
Ironically, Mexico may not at this point have a strong desire to tax the foreign companies on the grounds that they have a PE in Mexico. Mexico's primary objective may instead be to limit the number of companies that are eligible for the lower income tax rate. If so, Mexico might be well advised to concentrate directly on that issue (holding aside the question whether it would be wise to place new conditions on obtaining the benefits of that rule).
Having chosen for whatever reason to grant maquiladora programs to all former PITEX companies three years ago, it would be difficult for Mexico to unscramble that egg and achieve its objectives through general restrictions only on some maquiladoras without harming its competitive position in attracting and retaining export manufacturing operations or violating the terms of the mutual agreement and the protections that taxpayers have under Mexican law against inconsistent treatment or retroactive changes in the tax law.
Mexico is well aware of the tax enforcement tools it has at its disposal to audit any restructuring transactions that companies have undertaken before or after November 2006, and it would be well advised to rely instead on that authority to achieve its objectives. Like other Mexican companies, maquiladoras are subject to audit as to whether any sales of equipment to an affiliate were at arm's-length prices, whether their ongoing intercompany transfer prices comply with Mexico's transfer pricing rules, or whether there were transfers of intangible assets from a Mexican company to a foreign company that the taxpayer did not acknowledge. The Mexican tax authorities have been vocal about the need to scrutinize any business restructuring, such as the implementation of consignment manufacturing by a company that currently operates under a different business model, and to tax the company on any transfer of an intangible to a foreign party that occurs as a result of the restructuring.
The problem that Mexico faces in that regard is that most maquiladora restructurings may not be subject to attack under normal tax rules because the restructuring of export manufacturing operations often does not involve any transfers of an intangible that could justify the imposition of a tax deficiency and because maquiladoras that have restructured their operations are usually careful to adopt conservative transfer pricing policies. It would, however, be difficult to justify the imposition of new and potentially retroactive limitations on the application of the generally applicable tax rules to a taxpayer that has complied with applicable law in implementing a restructuring of its operations in Mexico, especially if the new limitations could call into question Mexico's compliance with its obligations under the mutual agreement.
In any case, Mexico's new single-rate tax generally applies to the gross amount of the proceeds of a maquiladora's sale of its equipment. That already has the effect of either deterring overly aggressive transactions or taxing them, and has had that effect since January 1, 2008. This additional tax is either an existing tax cost for restructuring a former PITEX operation to operate under a consignment manufacturing arrangement or a strong tax incentive to limit the scope of such a restructuring in a way that allows Mexico to continue to collect a more substantial amount of tax from the maquiladora under the transfer pricing method that Mexico can require a foreign company to apply in compensating a maquiladora that owns a substantial amount of physical assets.
Summing Up
Mexico has maintained a favorable tax regime for export manufacturing operations under its maquiladora program through the years despite its many tax law changes. At the same time, it has streamlined some aspects of its maquiladora program, and it appears to be open to further refinements that will make life easier for foreign companies wishing to establish or expand their export manufacturing operations in Mexico.
The Mexican administration reaffirmed the importance of maintaining a favorable tax regime for maquiladoras and sustaining its commitment to foreign investors when it issued the presidential decree in November 2007 that protects maquiladoras from a large increase in their tax burden under the single-rate tax, while ensuring that Mexico will collect income tax and single-rate tax from maquiladoras at a combined rate of 17.5 percent (17 percent in 2009) on a base that is close to being equal to its income tax base.
Mexico should stick to that policy and not make changes for many maquiladoras in the tax treatment that has always been available to them -- and that some have counted on in structuring their current operations -- in a way that would call into question Mexico's past commitments and future reliability. Mexico can instead rely on its existing tax rules to moderate any tendency to engage in aggressive restructuring and to audit positions that some taxpayers may take in violation of Mexican law.